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What Is Stop-Loss Order In Stock Market?

Submitted by admin on October 22nd, 2024

A stop-loss order is the simplest way to ensure you do not lose too much money in the stock market. Imagine it as a safety net for your investments. It works like this: when things go wrong, you have to set a selling price for the stock. When the price drops to that extent, it automatically gets sold and saves you from getting burnt in excess.

How it works

You buy a stock for ₹ 500 with the hope that it will gain. But the stock market being so unpredictable, that you want to get out when it drops to ₹ 450. So you give stop-loss at ₹ 450. Now if the stock were to drop to ₹ 450 your stop loss order would trigger and the sale of your shares would be automatically done. That way, you limited your potential loss to ₹50 per share without keeping an eye on the market all the time.

Why Use a Stop-Loss?

The most common reason most investors input stop-loss orders is the pain of seeing their investments sink. It helps you remove emotion in trading. For example, if the market starts sinking, you will panic and sell at the wrong time or worse, hold on to a losing stock. This allows you to stay disciplined in your trading plan and cut your losses.

It also comes in handy if you cannot monitor the market day and night. You can just set it and forget it, since the order will automatically sell your stock when it hits your chosen price, even if you’re not around or paying attention. This can be especially very useful if you have a very busy schedule or if you simply don’t want to deal with market stress.

Real Life Example

Let’s break it down with a real-life scenario. You buy at ₹100 because you expect the stock price to go up. As an added precaution, you also set a stop-loss order at ₹90. So when the stock price goes down to ₹90, your shares will get sold automatically, thus ensuring that your loss is limited to ₹10 per share. Without the stop-loss, you have to watch the stock all day or risk losing more with the continuous decline in the price.

Pros and Cons

The benefits of a stop-loss order are pretty obvious; it helps a trader manage risk and automatically execute, meaning you don’t have to keep checking the stocks you’re trading; it also helps remove some of the emotion from trading because there will be less enticement to hold onto a stock when it’s falling in hopes that it is going to bounce back.

The downsides, however, do exist. Markets can get totally crazy and sometimes will whip a stock down just long enough to hit a given stop-loss and then bounce right back after you sell. You end up selling your stock too early and losing the future gains because of it.

In a Nutshell

The stop-loss order is like having a built-in safety switch on your stock investments. You get to determine how much you are willing to lose and sell that stock automatically when the limit is reached. It is good for risk management and not making impulsive decisions; however, never forget that short-term volatility could activate it before you think.